Vegetable Grower Fujing Revives IPO, but Falling Margins Sow Doubt

The producer of premium vegetables for the restaurant trade can boast higher gross margins than its peers, but business risks cloud the outlook

Key Takeaways:

• Fujing Holdings applied for a fourth time to list its shares in Hong Kong, with updated financials showing its earnings took a hit this year from the suspension of a key production base
• The company’s production model generates relatively high gross margins, but these have been declining in recent years

By Ken Lo 

Chinese farmers have a saying about the relative value of food crops, which puts vegetables above rice but below fruit in the pecking order. Still, one vegetable grower has achieved impressive profit margins by cultivating luxury lettuce, cabbage and other produce for fine dining.

Fujing Holdings Co., Ltd. is the biggest producer of potted vegetables in Shandong Province, serving hotels and upmarket restaurants. Container-grown vegetables have a higher nutritional value than produce from open fields and must meet stricter cultivation standards. The crops are sold at prices four to five times higher than vegetables grown in the ground, helping Fujing reap wholesome profits.

In addition, potted vegetables can be planted up to 14 times a year while those grown with traditional methods can only be sown two to six times. That’s another business benefit for Fujing, which is hoping to entice investors with a share listing on the Hong Kong Stock Exchange.

The company last week submitted an updated prospectus for its fourth listing attempt, after three earlier bids expired. The latest version included earnings for the first eight months of the year. Fujing also announced it had enlisted CMBC Securities to work with Grande Capital as joint sponsors to take the company public as soon as possible.

What lies at the root of the company’s eagerness to harvest IPO funds? A closer look at the business performance reveals growing operational risks.

According to the prospectus, the company’s gross margin exceeded 40% for the past three financial years, although the level has been trending downwards. Gross margin was 50.4% in 2019, 45.8% the following year and 44.5% in 2021. In the first eight months of this year, it fell slightly to 43.4%. Meanwhile, the company’s net profit margin plummeted to 19.8%, from a range of 30.5% to 36% in the three prior years.

To put this in context, gross margins at industry peers Jiangsu Provincial Agricultural (601952.SH), Tianshui Zhongxing Bio-technology (002772.SZ) and Gansu Yasheng Industrial (600108.SH) are only around 20%. The recently listed Chongqing Hongjiu Fruit (6689.HK) logged a gross margin of only 19.6% in the first five months this year, while IPO hopeful China Pagoda came in at 11.5% in the first half of 2022.

Largest growing base suspended

Despite the high gross margin, Fujing’s cost of sales has been climbing. Last year, its raw-material costs rose 28% while labor costs jumped more than 31%. Aggregate sales costs climbed 30.6%, outpacing a 27.5% increase in revenue and weighing on gross margin.

The company’s revenue and profit had grown steadily over the past three financial years. Revenues totaled 118 million yuan ($16.9 million) in 2019, rising to 121 million yuan in 2020 and 155 million yuan last year. Meanwhile net profit went from 39.02 million yuan to 47.30 million yuan over the same period. But times turned tough in 2022, as Covid disrupted production and dampened dining demand. Revenue tumbled nearly 28% to 72.50 million yuan and net profit halved to 14.38 million yuan. Sales were depressed for months by lockdowns in Shandong and Dalian and the suspension for more than a month of its primary Laixi production facility. Sales did not return to normal until August, the company said.

Fujing runs three bases for vegetable cultivation, with a combined area of more than 430,000 square meters. The Laixi facility accounts for 90% of total sales, making it the biggest contributor by output and revenue. The production halt at the key growing base inflicted a heavy blow on the business.

The company sells under the main brand “Fujing Agriculture”. It produces 31 types of vegetables such as lettuce, cabbage and edible chrysanthemum, relying on a network of distributors to sell to more than 1,000 clients in Shandong, Xi’an and Dalian, mostly hotels and high-end restaurants.

Aspects of the company’s performance record could sow seeds of concern for investors. First, gross margins and net profit margins have been gradually wilting over the years, pointing to intensifying competition in the market. Moreover, recurring pandemic outbreaks and lockdowns have dampened economic growth and consumer confidence. The disruption to the restaurant business has eaten into sales of finely cultivated vegetables.

Unpaid bills from core clients

In addition, heavy dependence on a small group of customers has compromised the company’s bargaining power and left it exposed to late payments from downstream distributors. Trade receivables, outstanding sums owed to the company, have been piling up.

In the past three and a half years, the revenue share gained from its top five customers jumped from around 56% to 70%. Its single biggest client now accounts for 16% of revenue. The concentrated client base has increased the risk of unsettled bills turning into bad debts.

The company’s trade receivables reached 44.30 million yuan in the first nine months of this year and continued to rise, according to the prospectus. The company said it had started to set aside provisions in case a significant amount of trade receivables turns sour, potentially hurting its operational and financial performance.

To estimate its IPO valuation, we can use the price-to-earnings (P/E) ratios of three food industry peers as a reference. Jiangsu Provincial Agricultural, Tianshui Zhongxing Bio-technology and Gansu Yasheng Industrial have P/E ratios of 23 times, 15 times and 94 times respectively.

If we apply the average of 44 times to a Fujing annualized net profit of 21.57 million yuan, extrapolated from its eight-month earnings, the valuation comes in at 950 million yuan. The upmarket vegetable company would likely need to reverse its falling revenue and gross margin to reassure investors and achieve a premium valuation.

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